D. Life Settlements

The term life settlement refers to any financial transaction in which the owner of a life insurance policy sells a life insurance policy to a third party for some form of compensation, usually cash. A life settlement would require an absolute assignment of all rights to the policy from the original policyowner to the new policyowner.

Policyowners may choose to sell their policies because they feel they no longer need their coverage, or the premium costs have grown too high to justify continuation of the policy. In many cases, however, life settlement transactions are offered to senior citizens who may have a life-threatening illness and a short life expectancy. In these situations, the owner may elect to sell the policy to a life settlement provider for an amount greater than what they would receive if they surrendered the policy for cash value.

1. Disclosures

To help the owner understand the benefits and consequences of a life settlement transaction, at a minimum, the following information must be included in the disclosure:

• An explanation of possible alternatives, including accelerated benefits offered by the insurer;
• That some or all of the proceeds of a life settlement contract may be taxable;
• The proceeds of a life settlement contract may be subject to the claims of creditors;
• Receipt of the proceeds may adversely affect the recipient's eligibility for public assistance;
• That the proceeds will be sent to the owner within 3 business days after the life settlement provider has received acknowledgement that ownership of the policy has been transferred and the beneficiary has been designated according to the terms of the life settlement contract;
• That entering into a life settlement contract may cause other benefits under the policy, such as conversion or waiver of premium, to be forfeited by the owner;
• The total amount paid by the life settlement provider, as well as the net amount to be paid to the owner;
• The date by which the funds will be available;
• That the life settlement provider is required to furnish to the owner a consumer information booklet;
• That the insured may be contacted by either the provider or the broker to determine the insured's health status or to verify the address (the provider or broker must also disclose that the contact will be limited to once every 3 months if the insured's life expectancy is more than 1 year, and no more than once a month if the insured is expected to live 1 year or less); and
• The life settlement provider's name, business and email address, and phone number.

A life settlement licensee or provider is also required to disclose that the owner has the right to rescind a life settlement contract within 30 days after the contract is executed by all parties and the owner has received all the disclosures, or within 15 days of the receipt of the life settlement proceeds by the owner, whichever is sooner. Rescission by the policyowner is effective only if both notice of rescission is given and the owner repays all proceeds and any premiums, loans, and loan interest paid on account of the provider within the rescission period. If the insured dies during the rescission period, the contract will be deemed to have been rescinded subject to repayment by the owner or the owner's estate of all proceeds and any premiums, loans, and loan interest to the provider.

2. Fraudulent Life Settlements

Stranger-originated life insurance (STOLI) is a life insurance arrangement in which a person with no relationship to the insured (a "stranger") purchases a life policy on the insured's life with the intent of selling the policy to an investor and profiting financially when the insured dies. In other words, STOLIs are financed and purchased solely with the intent of selling them for life settlements.

STOLIs violate the principle of insurable interest, which is in place to ensure that a person purchasing a life insurance policy is actually interested in the longevity rather than the death of the insured. Because of this, insurers take an aggressive legal stance against policies they suspect are involved in STOLI transactions.

Note that lawful life settlement contracts do not constitute STOLIs. Life settlement transactions result from existing life insurance policies; STOLIs are initiated for the purpose of obtaining a policy that would benefit a person who has no insurable interest in the life of the insured at the time of policy origination.

Under the California law, anybody purchasing life insurance on another individual must have an insurance interest in that person. If there is no insurable interest, the insurer has a basis for declaring the policy void. The state law also prohibits issuing insurance policies as wagers on people's lives. STOLI arrangements violate these rules and are illegal in this state.